Treasury and the IRS promised to release guidance on direct pay and transferability “before summer,” and with proposed regs (REG-101610-23) issued June 14, they met their deadline admirably. Announcing a precise time frame for when proposed rules will be released is less important than their substance, but it’s still a practice that the IRS and Treasury should continue.
It’s painful to hear government officials intone the refrain that “guidance should be coming soon.” Let’s have more dates to put on the calendar.
Clarification of the rules under sections 6417 and 6418 is what taxpayers wanted in the proposed regulations, and that’s what they deliver — for the most part. They are less generous than some commentators had hoped. The market for credit transfers will be less expansive than it might have been had the passive activity rules been swept away.
At least for now, the proposed regulations don’t allow an applicable entity to purchase a credit and then seek an elective payment for the credit, although the preamble indicates that the IRS and Treasury will entertain possible exceptions. The registration process still has large open questions, but the transferee gross income exclusion is a welcome clarification for potential buyers.
The proposed regulations add necessary details to the new regime and include policy decisions. The elective payment rules appear to be intended to enable the use of elective payment, said Adam Cohen of Holland & Hart. Cohen pointed out that instrumentalities and agencies of state and local governments, as well as U.S. territories, are included within the definition of applicable entities in the proposed section 6417 rules.
The exclusion of partnerships seems incongruous, but the complexity of applying sections 6417 and 6418 may explain it. “From a tax logic perspective, they found the right balance, particularly in the section 6418 regulations,” said Chaim Stern of Schulte Roth & Zabel LLP.
Combining Transfers and Elective Payment?
The answer to whether an applicable entity could purchase credits under section 6418(a) and make an elective payment election is proposed to be no – but not a completely firm no. The preamble to the section 6417 rules says that its conclusion that “sections 6417 and 6418 are best interpreted to not allow an applicable entity under section 6417 to make an elective payment election for a transferred credit under section 6418” was informed by administrative and practical reasons given by commentators.
The preamble also connects its conclusion to the text of section 6417(a). Treasury and the IRS explained that they believe that transferred credits are not “determined with respect to” an applicable entity, as required by section 6417(a).
That is because the credit is not determined with respect to underlying applicable credit property owned by the applicable entity or electing taxpayer, or activities otherwise conducted by the entity or taxpayer under section 6417(a).
And the proposed section 6418 regulations say that transferees are not considered to have owned an interest in the underlying credit property or to have otherwise conducted any of the activities that give rise to the credit. That isn’t a statutory reason to disallow chaining, but doing so maintains consistency between the two sets of proposed regs.
The preamble invites comments on possible exceptions to the proposed bar on chaining, indicating a surprising flexibility that is tempered by the specificity that’s also requested. Suggested limitations to any exceptions include the type of applicable entity that may be allowed to make a direct payment election for credits transferred to it — government entities are offered as an example — and the transferee taxpayer’s involvement in the project’s development.
The other possible considerations are more difficult to distinguish from other types of transfers. They include the transferee’s due diligence, the fact that the transferee pays close to the face value of the credit, and the lack of other special financial arrangements between the parties. Transferees of all types should be expected to do due diligence, and they’ll likely all pay about 93% to 98% of the credit.
The outlined considerations suggest that Treasury and the IRS might provide exceptions if they are satisfied that they won’t be opening the transfer and elective payment regimes up for fraud or abuse. Commentators will almost certainly advocate for exceptions.
Registration
In order to claim the benefits provided by section 6417 or 6418, taxpayers must complete prefiling registration requirements in accordance with temp. reg. sections 1.6417-5T or 1.6418-4T. The online registration portal isn’t ready yet, but the preamble to the temporary regs says its opening deadline of fall 2023 is one justification for putting out temporary regs instead of proposed rules.
Transferees and elective payment claimants will need to reference their registration number when claiming their credits, which raises the question of how long it will take the IRS to review pre-registrations. The FAQs warn taxpayers to leave enough time to obtain a registration number, Cohen noted, but it isn’t clear what that means. It may depend on the depth of the IRS’s review, another open question.
Seth Feuerstein of Atheva, a marketplace for IRA credits, said it would be helpful if the IRS offered the timeline it expects to follow for assigning registration numbers to taxpayers. “It could create a problem if the IRS says they’re not able to review a pre-registration in time and the transferee can’t take the credit,” he noted.
It also isn’t clear whether the review will be substantive or focused on limited items intended to prevent fraud. Feuerstein said it should be the latter. “It’s not clear why a substantive review of a transferred credit would be more critical than a substantive position any taxpayer is taking,” he said.
Under the temporary regs, taxpayers will register eligible credit property and the registration number will apply to all the credits associated with that property. For production tax credits, that might lead to some tracking and accounting challenges.
Because the registration number will refer to the underlying property rather than the unit of production, if a taxpayer sells production tax credits from a single facility to multiple buyers, those amounts will all have to be added up and accounted for under a single registration number.
Stern said a better idea would be to register each unit of production as it is produced. “If a solar facility that is producing electricity has a single registration number for its production and sales to various buyers over the course of a number of years, it becomes very hard to track the total credit amount,” he said.
That increases the risk of double counting. A separate registration number for each unit would make the tracking simpler for taxpayers and the IRS.
Gross Income Exclusion
The proposed section 6418 regulations give many commentators what they sought regarding how to treat the difference between the amount a buyer pays for a credit and the amount of the credit that the buyer claims. Affirming what some congressional staffers indicated, that amount is excluded from taxable income under the proposed regs.
The rationale for the transferee gross income exclusion is that under section 6418(a), the transferee is treated as the taxpayer for purposes of title 26 concerning a transferred eligible credit. The preamble explains that an eligible taxpayer wouldn’t have gross income from claiming the credit, and the transferee shouldn’t either.
But the statute doesn’t say that the transferee is treated as the eligible taxpayer, merely that the transferee is treated “as the taxpayer.” That language is how the transferee gains the ability to apply the credit to its own tax liability, but it doesn’t expressly address the transfer’s tax effects, or lack thereof, on the transferee. It only describes the treatment of the transferee after the transfer.
Congress should have more clearly excluded the delta of the purchase price of the credit and the claimed amount of the credit from the buyer’s gross income. A technical correction was never very likely, and it won’t happen now in light of the proposed regulations.
The practical effect of including the difference in gross income would be that transferees would pay less for credits to account for the tax they owe. Notably, in 2011, the IRS’s conclusion concerning transferable state credits contradicted the rule prescribed in the proposed regulations (CCA 201147024).
Monte A. Jackel of Jackel Tax Law said that the proposed exclusion is solely a creature of the proposed regulations, not the statute, since section 6418(b) is silent on the treatment of the transferee’s income, if any, because of the discount — section 6418(b)(3) says only that the consideration the transferee pays is not deductible.